Many first time homebuyers are too focused on getting the lowest interest rate on their mortgage. I was, too, when I bought my first home five years ago at age 27. Luckily, I worked with a mortgage broker who educated me about why the mortgage with the lowest rate isn’t necessarily the best mortgage for me. I became a mortgage broker myself so I could help others avoid this same mistake.
While finding a low mortgage rate is important, finding a mortgage that’s best suited to your financial needs is just as important. As I like to say, the mortgage with the lowest rate can help save you hundreds, but the wrong mortgage product can end up costing you thousands.
Here are the top five factors to consider (aside from a low rate) when you’re shopping for a mortgage.
1. Fixed vs. variable rate mortgages
If you’re a first time homebuyer, don’t automatically sign up for the safety and security of a 5-year fixed rate mortgage.
With a fixed rate mortgage, you don’t have to worry about your mortgage payment and interest rate changing because they are fixed for the duration of your mortgage term. Signing up for a fixed rate mortgage is sometimes referred to as “locking in.” Often, you’ll pay a price for that certainty: fixed rates are typically higher than the lowest interest rate offered by variable rate mortgages.
With a variable rate mortgage, your mortgage rate can change during your mortgage term based on a change to your lender’s prime rate. Although each lender sets its own prime rate, they almost always move in lockstep with the Bank of Canada’s overnight lending rate. (If our central bank increases interest rates by 0.25 percent, your lender’s prime rate is likely to go up 0.25 percent, and vice-versa.) Depending on your lender, your mortgage payment amount may or may not change when prime rate goes up or down–that’s why it’s so important to work with a mortgage broker who knows their stuff.
Carefully weigh the pros and cons of fixed versus variable before making a decision.
2. Prepayment privileges
If you want to pay off your mortgage faster, generous prepayment privileges come in handy.
Prepayments are powerful because they go directly towards reducing your mortgage balance, unlike a regular mortgage payment, which is split between interest and principal. In the early years of your mortgage, most of your money goes toward interest. Prepayments can help you save thousands in interest and pay off your mortgage years ahead of schedule.
Types of prepayment privileges include options to increase your payment, double up your payment or make lump sum payments. While most lenders offer prepayments, some lenders are more flexible than others. Monoline lenders (or lenders that are only in the business of mortgages) tend to offer more generous and flexible prepayments. If prepayments are important to you, a broker can match you with a lender that lets you maximize them.
3. Mortgage penalties
Now, I know what you’re thinking. I’m signing up for a mortgage. Why should I care about mortgage penalties? There’s no way I’m going to break my mortgage. While you may be right, there’s a chance you could be wrong. The facts speak for themselves. According to Canadian Mortgage Trends, 6 out of 10 will break their mortgage at some point. If you end up breaking your mortgage, wouldn’t you rather be with a lender that treats you fairly in terms of its mortgage penalties?
With a variable rate mortgage, you’ll typically pay three months of interest as a penalty for breaking your mortgage. With a fixed rate mortgage, your penalty can be a lot heftier. You’ll usually pay the greater of three months of interest or something called the Interest Rate Differential, which factors in your lender’s mortgage rates today against rates from the day you initially signed your mortgage. It’s this calculation that can result in heavy mortgage penalties. Each lender’s calculation of the Interest Rate Differential is different, but monoline lenders tend to offer fairer mortgage penalties than big banks and credit unions. If there’s any chance you could break your mortgage, look for a lender with a lower mortgage penalty.
If you don’t enjoy paying hefty mortgage penalties (I have yet to meet someone who does), then it helps to choose a lender with a mortgage that’s portable. With a portable mortgage, you can take your mortgage with you should you choose to sell your existing property and move to a new one during your mortgage term, and you’ll avoid paying a mortgage penalty. Some lenders let you blend and extend your mortgage if you’re buying a home for a greater purchase price.
5. Standard vs. collateral charges
Before signing up for a mortgage, be sure you ask if it comes with a standard or collateral charge–this information is often buried in the fine print. The word charge may be a little confusing, because this isn’t a fee that you must pay. A charge is the name of the document you sign to secure your mortgage; this is the document that your lender registers with the provincial or territorial land registry. A standard charge covers the specific amount, term and interest rate of your mortgage. A collateral charge, on the other hand, can be used to register multiple loans with the same lender, for example a mortgage and a line of credit.
A standard charge mortgage makes it easy to shop around and switch lenders when your mortgage comes up for renewal, usually at no cost to you. With a collateral charge mortgage, it makes it easier to take out a home equity line of credit (HELOC), but that convenience comes at a cost. You may be required to pay legal and appraisal fees to switch lenders. If you don’t plan to take out a HELOC, you’re probably better off with a standard charge mortgage.
Buying a home is most likely the single biggest financial transaction of your lifetime, so give it the attention that it deserves. Before you start shopping for a mortgage, take the time to figure out what your personal financial priorities are so it’s easier to work with a broker to find the mortgage that works best for you.